Friday, November 30, 2012

Hiding Conservative Rage Behind Economic Jargon

-- Posted by Neil H. Buchanan

Three days ago, my Dorf on Law post focused on an odd controversy regarding how people say they will respond to the potential tax increases on the wealthy that might soon become reality in this country.  With many conservatives still surprised by the (completely predictable -- and accurately predicted) re-election of President Obama, apparently more than a few are now in panic mode.  They are certain that Obama will somehow get a big tax increase enacted into law, and they are promising to react badly if he does.

In some ways, this is reminiscent of the last, worst argument that supporters of the now-forgotten Romney/Ryan ticket offered earlier this month, the essence of which was: "Vote for Romney, because we're going to be even more obstructionist if Obama wins a second term.  At least something will get done with Romney in the White House."  Many commentators rightly denounced that threat as tantamount to blackmail.  Similarly, the wealthy supporters of the losing side in the election are now saying something like this: "Forget about Congress.  We'll sink the whole economy by refusing to earn slightly reduced profits and incomes, if you try to tax us."

Most of the don't-touch-our-high-incomes pronouncements have been coming from reasonably high profile people, such as the CEO of a pizza chain who continues to complain about tax increases in the Affordable Care Act.  (What is it about pizza chain guys that makes them crazy?)  These people directly hold the economic fates of at least several thousand people in their hands; so even if their threats are morally indefensible, at least we can see why they draw attention.  The New York Times article that I discussed on Monday, however, became infamous because it included an interview with a chiropractor whose income is currently (according to her) just below the $250,000 magic cutoff that Obama has set for any tax increases.  Her message was, basically, that she and her business partner (who is also her husband) will stop working as soon as their income hits the tax-increase threshold.

In one sense, this counts as a big "so what?"  She and her husband are threatening, in essence, to furlough themselves without pay.  Yes, that could show up in a lower Gross Domestic Product, as they would provide fewer spinal adjustments, and as any reduced spending on their part multiplied through the economy.  On the other hand, if their clients go to other chiropractors, or simply spend their money on other goods and services, then there might be no net effect at all.

As I explained on Monday, however, the article became infamous because some left-leaning news sources picked it up as an example of how the supposed non-moochers do not even understand how taxes work.  The argument, from people like Rachel Maddow, was that the chiropractors in question were making a basic logical error, confusing marginal tax rate changes with average tax rate changes.  I argued, in an indifferent sort of way, that that conclusion was not supported by the record.

The question comes down to this: When this person said that she will stop working as soon as her income reaches $250,000, if Obama succeeds in increasing the marginal tax rate for people like her from 33% to something like 36%, did she mean: (a) "If the tax rate rises to 36% at $250,001, then I'll actually be worse off by grossing $251,000 (netting $160,640) than if I stay at $250,000 (netting $167,500)," or (b) "If the tax rate rises by 3%, I will stop working, because it is worth the effort to gross an extra $1000 if I end up with $670, but it's not worth it if I end up with $640."  If the answer is (a), then she is truly confused (on several grounds, actually, because her current 33% rate does not even apply to her full income, so that her net pay is much higher than $167,500).

Nothing in the article definitively tells us whether the answer is (a) or (b).  My listless defense, however, should not be viewed as a statement that it would somehow make sense for this couple to actually stop working under the assumptions described here.  Part of the reason that Maddow and others assumed that the answer was (a), I suspect, is that answer (b) actually seems more silly.  Even if the taxpayer in question is fully cognizant of how marginal tax rates work, it just seems utterly implausible that we are talking about tax changes that are sufficiently large to cause people to stop working.  It might be theoretically plausible that (b) is at work, but in some ways it actually seems more generous to say that these people are ignorant of how taxes work than to assume that they would actually change their behavior on the margin because of the difference of $30 take-home on a thousand dollars of extra income.

In some ways, therefore, we are trying to figure out how to explain real-world behavior, in light of two issues: (1) Standard economic theory confidently predicts behavioral changes based on rational actors' responses to clearly understood changes in incentives, and (2) Statistical evidence suggests that people do not, in fact, respond to changes in after-tax rates of return, in most circumstances.  On the latter point, for example, I noted in a Verdict column earlier this year that public finance economists are starting to acknowledge that even large changes in marginal tax rates (for example, in capital gains) are apparently uncorrelated with any of the effects predicted by our models.

After I wrote my post on Monday, I saw that Warren Buffett had published a new op-ed in the Times that same morning.  Buffett, who continues to engage in "class betrayal" by arguing for increases in taxes on investors and wealthy people like himself, argued that investors simply do not think about tax rates when they consider whether to put their money into promising deals.  He repeated that sentiment the same evening on The Daily Show With Jon Stewart.

Buffett might have been making one of two arguments, along the lines of (a) and (b) above.  Either investors simply do not think about tax rates, because they are after the big score, or they think about rates, but they are satisfied with the rate of return on their investments -- even when, as was the case earlier in Buffett's career, tax rates were much, much higher than they are today.

On the flipside of this type of claim, I once had a conversation about estate taxes with a prominent public finance economist.  He said that estate taxes surely discouraged people from amassing large estates.  I pointed out that none of the studies of the estate tax had found such an effect.  He responded that it simply must be true that the estate tax has that effect, because it makes no sense for it not to do so.  In short, he did not respond to me by saying that he had seen other studies that contradicted my assertion.  He simply said that his theory had to be right, because it made sense to him.  (He then accused me of favoring a tax system that would "fit in well in North Korea," but that is a different story.)

In short, even though it is possible to defend the economic rationality of people who might quit working (or reduce their efforts) in response to tax rate increases, that is rather thin gruel.  We have a body of evidence that shows that, even if we view the evidence in the light most favorable to the chiropractors in question (and others like them), the big tax freak-out can only come about if higher-income taxpayers begin to act in ways that is either directly against their interests, or is inconsistent with the way that they have defined their interests in the past (that is, that is inconsistent with their responses to tax changes in other circumstances).  Along the lines of an argument that I made on Monday, that latter possibility is most consistent with the idea that wealthy people's utility functions include a variable that we might called "Obama Hatred."

If there is a sudden change in how wealthy people respond to tax changes, therefore, we will know that they really are willing to harm other people to spite a man whom they despise.  They might say that they are "merely responding to incentives," but that merely puts a bland label on an ugly truth.

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